When it comes to numbers, there is always more than meets the eye. In operational finance, you will learn how to read the “story” that the balance sheet and income statement tells about the company’s operations. The insights you gain from this “financial story” will then become a tool for short-term decision-making at the top management level relating to current assets, current liabilities and the management of working capital. Finally, by the end of the course you will understand the financial consequences of managerial decisions on operations, marketing, etc.

AC

Fantastic course, such a well laid out structure, Miguel sir explained with such enthusiasm, especially the case with Working Capital as to why it's not an asset. An excellent course!!!

JF

Jul 01, 2018

Filled StarFilled StarFilled StarFilled StarFilled Star

Amazing course, the questions posed are very insteresting and you actually have to think to be able to solve them. The best course of the first 4 courses of this specialization.

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Week 4: Negative NFO and DuPont Analysis

In this final week, we will introduce the final pieces of the puzzle to give you a complete overview of operational finance. We’ll discuss tools like sensitivity analysis that will help you consider the potential outcome of a decision given different variables. In this session we will also look at other crucial concerns for the firm and its shareholders like sustainable growth and ROE (Return On Equity) plus revisit NFO (Need of Funds for Operations) and other topics. Objectives: By the end of this session, you should have a complete overview of the key aspects of operational finance. You will also understand what tools financial professionals use in order to make decisions to strengthen a company’s position.

Enseigné par

Miguel Antón

Associate Professor

Transcription

[MUSIC] Now, we just saw a brief recap of week three. I spent a little bit of time, but I think it's very good to recap and understand what happened before. Now, we're moving on to a sensitivity analysis. Now, you might say, what is in a sensitivity analysis? We want to understand what happens with the financial statements and what happens with the company if certain things occur. If certain things happen, let's see what is the effect of that in the P&L and in the balance sheet. This is what we call sensitivity analysis. Basically, a sensitivity analysis, how sensitive my results are to some key variable changes that can go from margin to prices to expansion, to many other things, right. And we are specifically interested in the effects of those changes in the P&L, specifically the profits, and the ROS, which is my profitability, and on the balance sheet, specifically my need of credit, which is what is balancing my balance sheet. Now, what can happen or what could happen? Well, I could ask you, I'm going to give you a list of some things that could happen, but there are many other things that could happen. For example, first thing that could happen is that new competition comes in and pushes prices down. If they push prices down, we might have to push prices down. Well, this is a new circumstance that could happen. Now it's not the case because we know that we are better than the competition and stuff, but we have to be ready in case it happens. Second, angry suppliers might say, well, you are paying me late, I'm going to raise the price of cost. What is going to be the effect of that on my financial statements? Or for example, our trucks are not enough anymore to sell what we sell, and we have to buy a new truck. Or we had a problem with an employee and we have to fire him and we have to pay some severance for him. Or the warehouse rents go up and we have to pay a higher rent. Or, you know, the economic outlook changes and we have to pay higher interest rates for our debt. Or imagine, I don't know, imagine Mr. Lichstein's wife, she gets very sick and she needs very expensive surgery. This affects the company because Mr. Lichstein has to take more money from the company for his personal reasons. Or suppliers agree on a just-in-time delivery of the products, which means that you don't have to keep almost anything in the warehouse. Or crisis hits and some customers take longer than expected to pay. Or even we review paying terms with the suppliers and we agree to an extension of ten more days to 100 days. Or, you could say, or even instead of growing at 25%, which is what we expected, we grow 35 or 40%. Or we grow much less than we expected. Now, can you see that all those things would have an effect in the P&L and the balance sheet? Now, with information that you have so far, you should be able to get an answer to those things. Now, can we actually do some classification of this because this could be too long? Well, it's very simple. Look, the first two points are related to gross margin. So we might change gross margin and see what happens with the P&L and the balance sheet. The following three elements are related to OPEX, tracks, salaries, or rent of the warehouse, that's OPEX. We can change OPEX and see what happens in the financial statement of the P&L and the balance sheet. Now, financial expenses, interest rates. This is going to be important because this will go into the PNL as financial expense that is coming from the interest that we are paying from the debt that we have in the balance sheet. The next one would be something related to dividends that we haven't talked about. We said Lichstein needs money to pay for the surgery of his wife. He might need to take some dividends out of the company, which means that profit would not be reinvested in the company when it's taken away, so equity doesn't grow. And then we do have something that is related to NFO, related to collection terms, payment terms, and inventory terms, which are all related to NFO and operational ratios. And the last one related to growth. You see, so we can tweak few things related to that, to see what happens. Let's just start with the first one. Now, if we change margin, what is the effect of that in our P&L and our balance sheet? Well, let me show you what happens in the current scenario. The current scenario was 25% growth, and then the margin was 23%. So if you remember, margin 23%, I'm showing you here a small summary of the P&L and the balance sheet and the uniform working capital. Have a look. And you see that in the P&L, I just put the most important things, right? I took away a little transportation and stuff, and in the balance sheet, I took away other current liabilities and stuff to just keep the most important things. As you can remember, ROS in this case is 1.7, 1.8, and 2 from 2008 to 2010, with a margin of 23%. And then you could see, if you remember well from the exploding credit that this is the line of exploding credit, 469, 598, and 744. Now imagine that prices of the competition are lowering down, and we have to lower prices or cost increases. Imagine that margin goes to 21%, what would happen? Well, if you do that, you see that margin that falls to 21%, what happens is that our ROS actually goes to the bottom. So if there is a drop in margin of just 2%, you see that we are in a gross of 0.1, 0.3%. So we are in a tough situation. Now, as you can see, the credit now is exploding more. 524, 727, and 968. Why is that? Why is it exploding more than before? The reason is very simple. Lower margin, lower profits. Lower profits, lower equity. Lower equity, working capital is going to be lower. So the the south mouth of the crocodile is going to go down. That's why it increases, right? Now, on the other hand, if margin, we increase prices, which we said that was the action plan, what happens? Well, if we go to margins of 25% you see that we jump to a pretty good gross, 3.2% up to 3.6%, which makes the company be more fed in a way with the reinvested profits. Which means that in the balance sheet, we're going to have much lower need for credit. We almost are okay with the 500,000 line of credit. So as you can see, as we increase margin, the ROS goes up. As we increase margin, NFO, in this case, is pretty stable because NFO does not depend on the margin that much. It depends on the operational policies and on the sales. And sales are growing at 25%. And then working capital goes up as we increase margin, because again, you are reinvesting the profit. And credit is going down as you increase margin. [MUSIC]